Here
is an interesting article that I wanted to share regarding the recent steady
decline of
subprime
mortgage derivatives:
Subprime Mortgage Derivatives Tumble for a Fourth Straight Week
2007-02-16 11:43 (New York)
By Jody Shenn
Feb. 16 (Bloomberg) -- A derivatives index used to bet on the riskiest U.S. mortgage bonds headed
for its fourth straight weekly decline as more lenders said they were losing
money.
Prices for credit-default swaps linked to 20 securities
rated BBB-, the lowest investment grade, and created in the second half
of 2006 have fallen 2.6 percent to 83 this week, and are down 15 percent
since Jan. 18, traders say. The decline, which indicates a deterioration
in the perception of credit
quality, means an investor this week would have paid more than $950,000
a year to protect $10 million of bonds against default.
The tumble is being
exacerbated by hedge funds using
the index to make bearish bets and a dearth of investors willing to use it
to make bullish bets, said investors such as Dean Smith of New York-based Highland Financial Holdings Group LLC,
which manages $2 billion including mortgage bonds. The cost to protect against
default using the index is more than two-and-a-half times that to insure individual
securities, Bear Stearns Cos. says.
“We've yet to see the floor on where these things can go,” said
Paul Colonna, a fixed-income manager for Stamford, Connecticut-based GE Asset Management,
which oversees $199 billion. “And it's not based on housing data or performance data” on
mortgages in the bonds.
The decline in the ABX-HE-BBB-07-1 accelerated last
week, pushing it down from 92.01 on Feb. 2 as the two biggest subprime mortgage
lenders, HSBC Holdings PLC and New Century Financial Corp., said more of their loans were going bad than they expected. Subprime home loans are made to borrowers with low credit scores or high debt burdens. New subprime mortgages are experiencing more delinquencies than in at least six years.
`Pure Sentiment'
ABX indexes plunged even as typical yield premiums on BBB- bonds remained at about 3 percentage points over the one month London interbank offered rate, according to RBS Greenwich Capital Markets. Typical swap premiums on a single bond rose by $50,000 per $10 million to $400,000, versus a $235,000 rise for ABX premiums to $918,000, according to Barclays Capital.
In
the ABX market, “almost the entire
price movement can be blamed on nothing other than pure sentiment-driven
selling,'' Bear Stearns analysts led by Gyan Sinha in New York wrote in a
Feb. 12 research report. Last year, the New York-based firm was the fifth-largest
underwriter of securities backed by subprime or home-equity loans, according
to newsletter
Inside MBS & ABS.
Sinha says some of the contracts are too cheap. “Maybe, I'm naive and really I should stop thinking about fundamental valuation in all these markets,” he
said on a conference call.
San Diego, California-based Accredited Home Lenders Holding Co. said Feb. 14 that it lost money last quarter and that the outlook was too uncertain to give guidance for this year.
New Indexes
New ABX indexes are created every six months by a group of securities firms including Bear Stearns, Deutsche Bank AG, and Goldman Sachs Group Inc., and London-based Markit Group Ltd. Each
series is divided to track swaps on bonds with different ratings. The
indexes indicate prices for credit-default swaps linked to 20 bonds, not prices
for swaps on each. Credit-default swaps provide
monthly payments to sellers of protection and payments to buyers when the bonds
aren't repaid as expected.
Last year, “a lot of dealers bought
protection in the single-name market to feed the CDOs and
subsequently bought the index as a hedge,'' said Roy Cantu, director for
trading of asset-backed bonds and related derivatives at Barclays Capital. “I
think the dealer community may have learned that this hedge did not quite
work.”
Managers of collateralized debt obligations and other funds with
experience in bonds usually use so-called single-name swaps and actual securities
to make bullish bets, said Andy Chow, who manages $6 billion in asset-backed
bonds and their derivatives at SCM Advisors LLC in San Francisco.
Hedge Funds
Hedge funds that make bets based on views of the economy's direction have
made the ABX market their “ vehicle of choice'' to bet against
housing and mortgage markets, said Scott Kupchinsky, a portfolio manager
and lead subprime analyst at pension fund manager TIAA-CREF in
New York.
Stock investors using ABX indexes to hedge positions or those
that might sell short shares of subprime lenders add another “unusual
burden of selling pressure,'' said Michael D. Youngblood, an analyst at Friedman Billings Ramsey Group.
A
short sale entails selling borrowed securities in the hopes of profiting
by acquiring them at a lower price later.
More lenders may
be using ABX contracts to protect against falling values for loans they plan
to sell, according to RBS Greenwich. Securities firms also appear to be using
more to hedge against drops in the value of CDO they create, said Greg Lippman,
head of asset-backed trading at Deutsche Bank.
–Editor:
Burgess.
To contact the reporter on this story: Jody Shenn in New York at +1-212-617-2380 or jshenn@bloomberg.net
©2007
Angel Reyes
Read more articles by Angel Reyes at AngelReyesBlog.com.